Libor Scheme Shorted Corporate Income

The Libor price-fixing scandal, in which the London-based bank and financial services company Barclays manipulated Libor submissions to give a healthier picture of the bank’s credit quality in 2007 and 2008, has had little material effect on credit unions, according to industry experts. However, corporates that owned Libor-indexed assets during the liquidity crisis of 2008 were underpaid on their investments.

Andrew McGeorge, vice president of finance for the $2 billion Service Credit Union of Portsmouth, N.H., worked for Barclays Capital in New York as an associate director early in his career and later as a senior portfolio strategist at the Kansas City-based CNBS.

Back in 2008, the scandal “likely cost credit unions some money” if they owned Libor-indexed assets, McGeorge said, because they were underpaid because Libor was set artificially low.

Corporate credit union interest income was affected more than natural person credit unions, McGeorge said, because corporates own more Libor-indexed assets like floating-rate securities and fixed-rate bonds with attached interest rate swaps.

“It wouldn’t have been enough to forestall the corporate crisis, though,” he said.

California Credit Union League Chief Economist Dwight Johnston, formerly of Western Corporate Federal Credit Union, agreed that corporates were probably underpaid on Libor-indexed assets during the crisis but not enough to “have made a dent in the losses due to bad securities.”

However, on the bright side, Johnston said, credit unions did benefit from a lower cost of funds as share rates were indirectly priced from Libor.

“WesCorp tied its pricing of certificates to Libor and a lot of credit unions priced off WesCorp rates,” he said.

McGeorge said the public disclosure of the price-fixing scandal hasn’t affected current Libor because the financial market is relatively stable. However, in the event of a financial crisis like the one experienced in 2008, Libor will tend to be higher, either because bank reporting will be more closely regulated or regulators will devise a more accurate method in which to set Libor.

Should a future banking crisis result in higher Libor, the interest costs on NCUA’s Guaranteed Notes would increase because more than 75% of the outstanding balance on these notes carry floating rates that are based upon Libor–of the $21.1 billion in remaining NGNs, about $16.4 billion have floating rates based upon the one-month Libor.

“However, since these notes are tied to legacy assets which also have Libor-indexed coupons, the net exposure the NCUA has to higher Libor is minimal,” McGeorge said.

So, as a rising Libor would increase the rates the NCUA pays to investors, interest earned off the legacy assets underlying them would also increase, offsetting the cost of corporate stabilization to credit unions.

Several U.S. banks are also implicated in the scheme, including Bank of America and Citibank, according to press reports.

“The Libor scandal was just one more piece of evidence of bad behavior by banks,” Johnston said. “It helped borrowers at the expense of savers and investors.”

Johnston predicted there will be lawsuits filed against participating banks, but the scheme did not result in devastating losses.

“In fact, some would argue that shaving the rates helped create an atmosphere of greater confidence than would have otherwise been the case had the markets seen what banks really had to pay,” he said.